10.1 Description of valuation techniques

Fair values of financial instruments are determined based on quotations available to the public on an active market; when no such quotations are available, using the valuation models applied to public quotations of financial instruments, interest rates and stock market indexes.

The fair value of debt instruments for which an active loan market does not exist is measured using the discounted cash flow method. Discount factors are determined based on the yield curve of government bonds shifted by the credit spread. It is calculated as at the date of issue in relation to the issue price, and leads to a parallel shift of the yield curve of government bonds at a fixed rate over its entire length, or as the difference between the yields of listed debt securities of issuers with a similar rating and operating in similar industries, and the yields of government bonds (in case of securities denominated in EUR, these account for bonds issued by the German government), multiplied by a ratio determined as at the date of the issue, which includes in the discount curve a specific risk of a given issuer.

For derivatives traded on an active market, fair value shall be the closing price on the trading date.

The fair value of derivatives not quoted on an active market including forwards and interest rate swaps (IRS) is determined using the discounted cash flows and the information used in the measurement of the instruments comes from the money market. Interest rate yield curves associated with a particular type of financial instrument and currency, constructed on the basis of available market data are used to discount cash flows.

The fair value of options related to the structured deposits is determined based on measurements of the option writers, considering verification of the measurements carried out by the companies in PZU Group based on internal measurement models.

Depending on the characteristics of a given real property, its fair value is measured using the comparable, income or residual method.

With the comparable method available, development land and some smaller and less valuable buildings are measured (such as residential premises, garages etc.). The comparable method is based on the assumption that the fair value is determined by a reference to the observable market prices, including adjustment ratios. The adjustment ratios take into account such factors as the passage of time and market price change trends, location, exposure, intended use defined in the local development plan, availability of means of communication and transport, area, neighborhood (including location against attractive facilities), investment opportunities, physical conditions, ownership, etc.

The income method consists in estimating the fair value of real property based on discounted cash flows. The calculation takes into account such variables as the capitalization rate, rental fee level, maintenance cost level, vacancy provision, losses on exemptions from rental payment and delinquencies, etc. The level of the aforementioned variables differs depending on the characteristics and intended use of the real property measured (office space, commercial space, logistic and warehouse space), its modernity and location (transport, distance from the city center, availability, exposure etc.), as well as local market parameters (such as the capitalization rate, rental fee, maintenance costs).

The residual method is used to determine the market value if the real property is to undergo construction work. The fair value of the real property is defined as the difference in value of the real property after the execution of construction works and average values of the cost of these works, including the revenues attained by similar properties on the market.

Fair value measurement of real property is performed by licensed appraisers. Approval of each measurement is additionally preceded by an inspection carried out by employees of the PZU Group entities aimed at eliminating potential errors and inconsistencies. Any doubts are clarified as they arise.

Investment property is measured in accordance with the following rules:

• properties held by investment funds being PZU’s subsidiaries – measured on a semi-annual basis – as at the last day of each year half and the financial year;
• investment property held by the PZU Group entities – the most valuable items are measured if indications of a possible significant change in value occur (most frequently, on an annual basis). Regardless of the value, each investment property is measured at least once every 5 years;
• properties held for sale – measured before being actively exposed on the market.